The Monetary Policy Debate: Austerity or Stimulus?

The global economy is unchartered waters at the moment. The world has never received a systemic financial shock like it did in 2008 when the Global Credit Crisis erupted and nearly destroyed the current global economy as we know it. Literally, there was a stretch of a few days during the fall of 2008 when the outcome was uncertain.

There was a small window of time where complete and utter chaos and economic collapse seemed imminent. However, global leaders gathered together and acted in unprecedented unity in order to stave off a financial Armageddon, as developed nations around the world slashed interest rates and injected trillions of dollars into their economies in an attempt to free up frozen credit markets and stimulate economic growth.

Now, over two years after the near-collapse, the global economy is still struggling to find a sure footing. The United States economy has definitely rebounded well of its lows of early 2009, but the long-term prospects are still daunting. The Federal Reserve had to inject a second round of quantitative easing into the economy in November 2010 in order to, hopefully, spur economic growth and job creation, which remain two persistent problems in the U.S.

In the Euro Zone, disaster seems to keep knocking on the door. First, it was the Global Credit Crisis, second, it was Greece needing a bailout, third, it was Ireland’s banking system needing a bailout, and now, it seems that Portugal, Belgium, and Spain are all in big trouble. Several peripheral countries in the Euro Zone are still facing recessions and contracting growth.

In the United Kingdom, prices are rising, but economic growth is not. That is one of the most deadly combinations a n economy can face because rising prices require higher interest rates in order to curb inflation, while a lack of economic growth requires the exact opposite in order to spur economic growth.

Thus, what is a country to do? Preliminary GDP figures came out in January 2011 a full percentage point lower than the market had expected.

The Monetary Policy Response: Do We Stimulate More?

This is the debate that is raging among economists and experts around the world. Should struggling countries continue to inject stimulus into their economies in hopes of jump-starting them, or should they rein in government spending and let the free market do its work?

In the Euro Zone, the European Central Bank and International Monetary Fund have opted for austerity. In order for Greece, Ireland, and other weak countries to receive bailout funds, these countries must first agree to very strict austerity measures. These measures typically include things like slashing government spending, which generally means cutting government programs and slashing government wages.

These countries do not receive their bailout funds in one lump payment. Instead, they will receive the funds in several distributions, and at each distribution the struggling country has to prove it has done what it was required to do. If it has not, then the struggling country will not get the next bailout distribution.

This can lead the euro drop quickly. A person can search for the best forex broker to find charting packages that allow a person to track the movement of the euro versus other currencies in the FX market. Keep in mind that trading currencies on margin is risky.

The United States, on the other hand, has not adopted any austerity measures. Instead, it has continued to spend money at a rapid rate. Currently, the United States has injected about $2.3 trillion into the economy over the last two years.

Back to our original thought in this article—we are in unchartered territory. The truth is that no one knows what the long-term effects of massive stimulus spending will be. Some believe that inflation will become rampant, while others believe there will be no inflation. Unfortunately, we are the mercy of time. In the end, time will reveal exactly what the consequences will be.